According to the latest economic forecast from the Bank of Estonia, the economic situation has strengthened: several sectors that were previously struggling have started to grow again, and the economy is expected to continue improving.

Next year, Estonia's expected economic growth is projected at 1.6 percent, with growth reaching approximately 3 percent in 2026-2027. Inflation, due to planned tax increases, will remain close to 4 percent over the next two years before slowing. The tax hikes will account for roughly one-third of the price increase over the next two years.

"Improvement in Estonia's economic outlook is evidenced by the growth in export volumes. Much of the recent economic downturn has been linked to setbacks in the export sector. Reviving exports is a necessary condition for sustained economic activity," the Bank of Estonia stated on Friday.

Recent data shows that the weak export performance in the third quarter was temporary. Afterward, the increase in exports observed in the first half of the year resumed. Estonian companies have found new markets, and this recovery is expected to further expand export opportunities, the central bank noted.

The support of exports in driving economic recovery is crucial, as domestic demand is expected to develop more modestly due to the government's plans to curb the deepening budget deficit.

"While restoring public finances will constrain economic growth next year, it will enhance the country's credibility in the eyes of creditors and investors, free up resources in the state budget for necessary expenditures instead of interest costs and ultimately contribute to Estonia's long-term economic growth," the central bank added.

In an interview with Vikerraadio, Bank of Estonia President Madis Müller said it is still too early to claim that Estonia's economy is in a very strong position, but there are signs of improvement, particularly in the turnaround in exports.

"By selling goods and services abroad, this is how Estonia can bring new wealth into the country," Müller added.

"In addition to our own decisions, we are highly dependent on the performance of the rest of Europe, which seems to be gradually improving, as in Sweden," Müller said. "What we heard at yesterday's European Central Bank Governing Council meeting suggests that no one is expecting a boom just yet."

Müller noted that overall, the data shows that Estonia's economy has not fallen deeper into decline in recent quarters and could start to improve moving forward.

Purchasing power slowly improving

The Estonian economy is heavily dependent on the performance of the European economy, which is expected to experience accelerated growth, albeit at a modest pace, according to the Bank of Estonia. The European Central Bank forecasts euro area growth at 1.1 percent next year and 1.4 percent the year after. However, uncertainty has increased for international trade due to concerns that the United States may impose stricter trade barriers. Such measures would likely dampen global economic growth and drive up inflation.

"The labor market has responded relatively little to the economic downturn so far, and no rapid changes are expected even as the economy recovers. Employment has not declined in line with the extent of the economic downturn, and since businesses have avoided layoffs, the initial economic recovery will not significantly boost hiring," the Bank of Estonia stated. As a result, unemployment will decrease only gradually, and subdued competition for jobs will slow wage growth to around 6 percent next year and approximately 5 percent in the following two years.

The slowdown in wage growth is also driven by businesses' need to restore previously diminished profitability. The share of income allocated to labor costs has reached near-record levels as companies prioritized retaining employees.

Household purchasing power is expected to recover slowly, with more pronounced improvement likely in 2026, the central bank predicted. Due to planned tax changes and rising living costs, real net wages (adjusted for inflation) are expected to decrease by about 1 percent next year.

A significant shift in purchasing power is anticipated in 2026 when the planned abolition of the income tax hump (Estonia's gradual income tax exemption reduction scheme – ed.) will allow the average real net monthly wage to increase by more than 4 percent.

The Bank of Estonia considers the impact of tax hikes on inflation to be temporary. This year, the consumer basket is expected to become 3.6 percent more expensive. Over the next two years, price growth will remain high due to the introduction of VAT, vehicle tax and excise duties, accounting for roughly one-third of the overall price increase. Inflation is expected to fall below 3 percent in 2027, with about a quarter of this driven by the implementation of a new emissions trading system within the European Union, the central bank noted.

Estonia's price levels have reached near the European Union average and, in some product categories, significantly higher. The high price level has already increased the share of cross-border purchases, and shopping from international online retailers is likely to grow further. This suggests that Estonian retailers will face tighter constraints on raising prices to remain competitive.

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